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how to talk to your teenager about personal finance

If you have children or younger relatives – particularly teenagers – then this thought probably crossed your mind at one point: “if only they would do some of the things I wish I had done!” Maybe you always dreamed of visiting Mongolia or taking a year off after high school to backpack around Europe. Perhaps you hope your teenaged children will take the leaps you never took. The most important thing you can do is to give them the basic skills to succeed in life. One of the best ways to do this is to teach the teenagers in your life how to invest.

Just as saving is a good subject for children to learn, investing is a great skill for teenagers. Sadly, investing is still not taught in most secondary schools, and many parents who are struggling to get out of debt may not have the background themselves to educate their children. Parents may be embarrassed to admit a lack of skills in this area, but just like “the talk” about sex or drugs, that embarrassment must be overcome for the teenager’s sake!

So what can you do? A few simple steps can be taken. None of them require a huge investment of time.

Open a custodial account. A custodial account is opened in the name of an adult “for the benefit of” a minor as a Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA), depending on your state of residence. Taxes are not collected until the teenager has more than $850 in income, at which point it’s taxed at the child’s rate. Above $1700 it’s taxed at the parents’ rate (these are 2007 limits). However, consider that in order for your investment to generate $850 in income at an 11% rate of return the amount invested would need to be greater than $7700. Include them during tax season by obtaining student tax software online which will get them accustomed to filing their own taxes.

Put some dollars in it. The amount is not particularly important. If you have the resources to give your child a lot of money to invest, do it. If you don’t have the resources, don’t worry – the purpose is to educate at an early age. Once they have their own money, they can invest it themselves. Your role is to start the fire, not to bring the logs.

Contribute a certain amount in lieu of gifts. So much angst is created in our consumer-driven society by a corporate-imposed mandate to buy love through “stuff.” Your child is going to whine when you don’t buy them an Xbox and instead give them $300 to invest. Your job as a parent is to show them, both in word and action, that until they make their own money, it is your money to spend as you see fit. Toys will be forgotten.

Sit down and explain the basics. You may not understand the basics of investing. Study. Read blogs, read some of the basic books on investing. You don’t need to understand option puts. You need to understand what a share is, why dividends are paid, what unrealized and realized gains and losses are. If you don’t understand these terms, study.

Don’t just buy a “how to” book, though. If you buy a cookbook and follow its directions point-for-point, you can probably bake a cake. Teachers don’t just stand in front of a classroom reading directions from a textbook point-for-point, though, and great chefs do not rush back and forth to check whether to add flour or bacon grease to a chocolate cake. They understand their subject well enough to teach it themselves, not just by reading a book aloud. Do the same with investing – read about investing, not “how to” invest. Sit down with them. Make sure you read the books at the same time as they do. Work through the book with them – make it a question-and-answer exercise.

Choose investments together; involve them. To illustrate this point, Bubelah and I made the mistake of steering her younger sister away from a “trendy” stock (AAPL) in favor of a “solid” one (INTL). Even though our reasoning was sound, the decision to buy a particular stock has to be the teenagers, not yours, or they will lose interest in investing. If you make the choices, it becomes another adult-driven enterprise that they have no “real” say in. If they want to invest in speculative risky investments that fail, let them! Losing money can be as much of a lesson as making money. Teenagers are young; they have time to recover from their losses.

Go over it every month or quarter or year to review what went right and wrong. Make sure you sit down and look at “what ifs.” What if that dividend had been reinvested? What if the money had been put in a CD instead of stocks? Maybe it would have been better, maybe it would have been worse. Make sure they understand the parts that went wrong – it may be even more important than understanding what went right. Simplify the process by investing in some inexpensive personal finance software.

If your teen makes some money, ask them to reinvest at least 10% of it, even it’s a single dollar. My own prejudice has always been that reinvesting is key to building wealth. Dividends and gains are not money for spending – not ever. Teach your teenager that just because they’ve received a dividend is no reason to spend it on “stuff.” Learn how to reinvest before ever even touching the money by using DRIPs (dividend reinvesting plans).

Teach them not to touch principal. I find the concept of a house’s foundation is useful. Before you can build a castle, you have to lay down a foundation. You can’t pull chunks out of the foundation just because you’re running short of concrete to build a tower. The base of an investment portfolio has to be thought of always and forever as untouchable.

Consider alternative ways of investing. Most of the examples I’ve given are equities, because that’s a low-barrier entry into investing. You can invest small amounts easily in the market. That doesn’t mean your teenager can’t learn about investing in real estate or businesses. The same lessons can come from successes and failures in those areas. If your teenager is more interested in building an online business with their investing money, let them. Help them decide, let them succeed or fail on their own, and help them review the results. Despite what the conventional wisdom of the retirement-planning industry may say, you can invest without putting money in the market.

Keep your teenagers engaged and interested, and you may even get excited about investing all over again. Remember that spending and saving habits are established in your early life. Small actions now can stoke the fire of determination to achieve financial success for a lifetime. You can provide the spark.

34 comments

I’ve done this for my sister. I opened a custodial account for her through Scottrade. A few years back I gave her a gift of $200 investing money. Then we sat down to talk about investing in general. The book that I got for her was The Motley Fool Investment Guide for Teens: 8 Steps to Having More Money Than Your Parents Ever Dreamed Of (Motley Fool) by David Gardner, Tom Gardner, and Selena Maranjian. I don’t believe she read it through because she had her school, homework and extracuricular activities to worry about. However, we went over the basics of investing and chose a stock to buy. She was excited. I never buy her presents since her tastes are quite expensive for my pocket (i.e. digital camera, etc.). I give her some money for her brockerage account for birthdays.
She also got a part-time job and my parents opened a savings account for her to put her money in.
Trust me, it worked with her, she understands the value of her hard-earned money and doesn’t swindle it for stuff (she asks my parents to do that ;o)

You mentioned that the income from the custodial account is not taxable until it reaches $850. Is this per year or cumulative? Also, does this include just interest + dividends or does it include unrealized capital gains as well?

@Brooke: I’m not a financial advisor so any advice I give has to be taken with that grain of salt. My wife and I use Sharebuilder (which is now part of ING) for our custodial accounts. I have always been a big fan of Sharebuilder for infrequent, long-term accounts. The trades are cheap ($4) and setting up a custodial account (or any type of account) is a breeze. That having been said, almost any of the big online brokerages are probably easy to use. I’d let Bubelah’s comment serve as our joint testamonial to how it worked for her sister.

@Mike: That is per year, but it does adjust each year – theoretically it will grow over time to account for inflation. It includes taxable income only (it’s also just restricted to “unearned” income, so it wouldn’t include a part-time job’s earnings). In the US taxable income wouldn’t include unrealized capital gains. Capital gains would be taxed as capital gains and would require the child to file an income tax return, where much more complicated rules start to apply (standard deductions, etc.), particularly beginning with 2008 tax returns. There’s a good article on it here. It gets complex very quickly and in 2008 the rules will become byzantine even by the standards of US tax law.

The way I look at it is that if you invest in growth stocks which pay low dividends but have a high potential future value you can leave them sitting there until the kid is out from under the provisions of the so-called “Kiddie Tax.” I have used VBR, for example – with a current yield around 2.5% you’d have to accumulate $68000 to break the $1700 limit (or $34000 to even start paying taxes).

Right now the age limit for the Kiddie Tax is 18 years old (after that you just pay normal adult tax rates) but in 2008 our kind and loving government has broken it into 3 different categories up to as old as 24 – probably to reflect young Americans’ increasing financial dependency on their parents. I sure hope Canadian taxes are less complicated.

I think that to get teenagers interested in personal finance, it really helps to use books that will be enjoyable for them. Bubelah, I haven’t read that particular Motley Fool book, but I’m sure it’s great for teens because the Motley Fool is always so entertaining. Nowadays there seem to be lots of finance books aimed at teenagers. I think The Millionaire Next Door, while not targeted at teens specifically, is very easy to read and can hopefully help teens fight the peer pressure to spend too much money. It also makes for good discussion.

Canadian taxes are not simple but from anecdotal evidence I would say that for a normal simple return a Canadian return would be easier than an American. This is strictly based on things I’ve read on blogs so it might not be true…

We’ve done this with our teenagers. We’ve been better with the second born than with the first. They have stock funds and custodial accounts. We never made our daughter save for anything and we regret it. Our son is about to get his license and wants a car. We’ve helped him set up an account in which he has to save $1,000 to contribute towards a car.

Earmarked for our 2 elder girls. The present investments were made without their input. (under their and their mother’s joint names.) They should be graduating later this year and we have to review the investments together.

The specifics you have mentioned may not apply for us, but the principles are great.

I think this is a great idea! I also think 529 accounts are a great idea…growing up, I had a bank account…I used to get really excited seeing a few dollars of interest…I would have loved being able to invest!

Some great advice, thanks. My 6yr old son has about $200 in cash in his dresser drawer from bdays, Christmas, etc. I have wanted to take him down to the bank and open a savings account with him, this post may just be the motivation I needed to stop procrastinating. Never to young to start instilling some of these ideas of savings with him.

An unintended consequence of this post was that it got people thinking, which is a cool result. I think even getting your kids interested in the concept of compound interest is a good start. Don’t go for the gold – nobody needs to shoot for 35% returns for their kids’ investments – but at least get things started in an ING or HSBC savings account.

I have a teenage daughter too and I would surely pass on these tips to her. I dont want her to get into financial troubles at an early age, like mama (sighs). Getting into debt is pretty common for young kids these days. The right financial advice at a young age is a step in making the child understand the value of money and managing it well. Its us parents who need to take the extra step in helping our child to know the real meaning of “managing finance”

I am sure I will keep reading your blog now for more information and tips, and to make it a little easy, i just subscribed to your rss feed. 🙂

Sam, thanks so much – I'm gratified that you found the article useful. You are completely correct that it's important to start teaching kids about personal finance at younger and younger ages these days. I'm not sure waiting until your kids are teenagers is even such a great idea – maybe I should retitle the article “how to talk to middle schoolers about personal finance”! Good luck and thanks again 🙂

Wonderful post. Parents should take more time to educate children in finance. The school system unfortunantly does not seem to teach teenagers the value of the dollar and how to set aside money. Teenagers need to understand that by hhard work and dillagence they can create a nice nest egg for the future. Thanks for the wonderful read and keep up the great posts.

Wonderful post. Parents should take more time to educate children in finance. The school system unfortunantly does not seem to teach teenagers the value of the dollar and how to set aside money. Teenagers need to understand that by hhard work and dillagence they can create a nice nest egg for the future. Thanks for the wonderful read and keep up the great posts.

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